SEC Fights for Its Right to Go Easy on Big Banks

A New York judge spent the holidays arguing with the SEC over its proposed settlement with Citigroup, which is accused of dumping risky assets on deceived investors. Judge Jed Rakoff rejected the settlement because he lacked “any proven or admitted facts upon which to exercise even a modest degree of independent judgment.”  Rakoff said the settlement doesn’t require Citigroup to admit or deny the allegations. He criticized the $95 million penalty as “pocket change” and “a very good deal” for Citigroup.  An SEC official said the decision strains agency resources and “ignores decades of established practice throughout federal agencies and decisions of the federal courts.”

Citigroup would have been required to answer the allegations, but the parties asked Rakoff to stay the ruling, pending appeal. The SEC filed a similar request with the Second Circuit, without informing the judge, and that court stayed the ruling, seconds before Rakoff filed his own order rejecting the request. Rakoff complained that he had spent Christmas working on the issue, only to be overruled.

When he rejected the settlement, Rakoff said he had insufficient information to determine whether it was in the public interest. “[I]n any case . . . that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth.”  Rakoff described the allegations as “tantamount to . . . fraudulent intent,” though Citigroup was only charged with negligence. The judge previously rejected the SEC’s settlement with Bank of America, but he approved it after the agency increased the penalty  from $33 million to $150 million.

The SEC said it does not require defendants to admit wrongdoing in settlements, but the fact that a practice is long-standing does not mean it’s right. (A recent media report quoted a SEC whistleblower describing the practice of “systematically destroying records of its preliminary investigations once they are closed.”) The SEC says the settlement is in the public interest, but in one court filing, it argued that “the public interest … is not part of [the] applicable standard of judicial review.”

Citigroup faces serious allegations: just before the financial crisis, the bank was concerned that it owned some very risky assets, so it set up investment vehicles for them and lied to investors about the risk. The bank’s clients lost hundreds of millions of dollars.

But it’s not about the money. As Rakoff said, these settlements will deprive us “of ever knowing the truth in a matter of public importance.”  Like other regulators, the SEC dropped the ball before the financial crisis. Large banks had catastrophic exposure to risky assets, and the public had to bail them out when they went bust.

The SEC is allowing banks to pay a small fine and sweep the misdeeds under the rug. The public must learn all it can about the roots of the financial crisis. A trial or admission of wrongdoing would help ensure markets that companies that mislead investors will be punished. Congress and the President must ensure the SEC has a clear mission and enough resources for tough enforcement. We should consider making the agency more accountable to political leaders. The public is still angry at Wall Street for wrecking the economy, and Judge Rakoff is right that these settlements constitute “half-baked justice.”